IBM Nips 3Q Estimates But Hardware Sales Slip

IBM on Tuesday managed to squeeze by analysts' estimates in its third quarter, posting a profit of $2.36 billion, or $1.68 a share, on sales of $24.1 billion.

This time around, IBM's services and software businessesas well as a weak U.S. dollarbailed out a disappointing performance from its hardware unit and helped the company overcome a slight decline in its overall gross profit margins. Analysts were expecting Big Blue to return a profit of $1.67 a share on sales of roughly $24 billion. Gross profit margins slid to 41.3 percent in the quarter, down from 42 percent in the year-ago quarter.

Hardware sales fell 10 percent from the year-ago quarter to $4.9 billion and almost $500 million below the target most analysts had set for its mainframe and server business. Technology services sales, however, surged up 14 percent to $13.6 billion and software sales rose 7 percent in the quarter to more than $4.7 billion.

Mark Loughridge, IBM's chief financial officer, said the company remains "on track" to meet its previously established earnings-per-share estimate for the full fiscal as well as its ambitious goal of returning a profit of at least $11 a share in fiscal 2010. However, he cautioned the company saw declining orders and sales to financial services customers in September and expects hardware sales and profits in the fourth quarter to be "flat" compared to the year-ago period.

"Obviously, hardware didn't meet our expectations," he said during a conference call with analysts Tuesday evening. "Overall, for hardware in the fourth quarter, I look for a more stable performance. We're working with our customers on migrating to new technology. I know we can do better as we go into the fourth quarter."

Putting aside the anticipated hit it absorbed for selling off its printing division, overall hardware sales fell six percent from the year-ago quarter. Its System z mainframe sales tumbled 31 percent from the third quarter of 2006. Its System i server sales plunged 21 percent and its storage unit only reported a one percent improvement from the same period last year. IBM's System x and System p UNIX server sales both grew six percent in the quarter.

"I think the way to characterize this is that we're going through a transition," Loughridge said. "We had eight quarters of sustained growth on this z series. I'd like to remind you that it's facing a tough compare (to the year-ago quarter) when sales were up 23 percent. To me, it doesn't look like real volatility and I don't expect more volatility going forward."

Despite the lackluster performance from hardware units, IBM still had much to cheer in the quarter.

The 14-percent improvement in revenue from its Global Services unit was the best quarter-to-quarter improvement since the third quarter of 2003. IBM signed services contracts worth more than $11.8 billion in the quarter, up 12 percent from the same period last year, and exited the quarter with services backlog of more than $116 billion, up $7 billion from the third quarter of 2006.

IBM's software division checked in with a profit of $1.28 billion, making it the single-most profitable unit in Big Blue's empire.

IBM CEO Sam Palmisano, in a statement accompanying the financial report, said the services and software results were "outstanding" but added the company has to "work through a transition in our hardware business."

In July, when IBM reported robust second-quarter sales and earnings, Palmisano said the company was well on its way to delivering earnings-per-share growth of roughly 19 percent in the next three years to reach the $11-a-share profit it projects for fiscal 2010. Most of that growth, he said, will be generated from sales into emerging countries.

IBM shares, which have rallied up more than 20 percent so far this year, closed up $1.57 a share, or one percent, to $119.60 ahead of the earnings announcement.

Fifteen of the 21 analysts following the company maintain either a "buy" or "strong buy" recommendation on the stock.

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